Markets: You pay your money and take your chance

There's a battle developing in the bond market between Goldilocks and the bears, with European investors split on the outlook for German and US interest rates.

Fans of US bonds are convinced the world's largest economy will continue to bask in a "Goldilocks" scenario, with Federal Reserve Chairman Alan Greenspan last week reinforcing the view that the economy is running neither too hot, nor too cold, but just right, with strong growth not endangering low inflation.

However, those enthusiasts warn that economic growth in Europe may rebound in the coming months. That may fuel inflation and prompt a rise in official interest rates from the German Bundesbank, sending European bond yields higher.

Others, however, expect US growth to kindle higher prices in the months ahead, spurring the Fed to raise rates even as the efforts of European governments to meet the Maastricht criteria mean economic growth on

the Continent remains lacklustre.

The dispute highlights how the much-vaunted "new paradigm" is making the job of economists and fund managers much tougher, as technological advances and improved productivity blunt the tools usually used to assess the state of the global economy.

With no consensus on the likely temperature of the US economy in the months ahead, it's harder for European investors to decide whether to stick their money in European bonds or Treasuries in the second half of the year.

"There's some value in longer US securities versus Dutch bonds from 10 years out," said Hans Grundeken, head of bonds at Kempen & Co in Amsterdam. "Since I believe the dollar will get stronger, you get 75 basis points more just for free. There's still value in Treasuries because the US currency is so strong."

In dollar terms, the 4.6 per cent return so far in 1997 on US bonds maturing in more than one year beats anything an investor could have on European bonds in any maturity, excluding the UK market.

With European politicians showing their willingness to bend the Maastricht rules on budget deficits to keep the euro timetable on track, there's scant prospect of European currencies staging a recovery. "European currencies should remain relatively weak against the dollar," is the view of Roman Gaiser, an economist at Louis Dreyfus Finance Banque in Paris.

Investors currently demand a premium of about 70 basis points to buy US 10-year debt rather than equivalent German bonds. US securities yield an annualised 6.25 per cent, compared with 5.55 per cent in bunds.

That spread, a measure of the additional risk investors perceive in Treasuries, is down from more than 90 basis points a month ago and from 100 two months ago.

Mr Greenspan gave Treasuries a further boost last week when he described the US economy as "exceptional," while his fellow Fed member Laurence Meyer said the performance of the economy is "enough to make you want to cheer".

While that was enough to smother any lingering concerns that the US central bank was poised to raise interest rates, some fund managers remain wary of a rebound in the US economy which would spoil the porridge.

"We fear that third-quarter US growth will be higher than in the second quarter," said Edith Siermann, who has stopped buying Treasuries and is stocking up on German bonds instead for Rotterdam-based Robeco. "Even if inflation is improving, cyclical pressures should build up one way or another."

In Germany, meanwhile, the Bundesbank has held interest rates at historic lows since August last year when it cut its securities repurchase rate to 3 per cent.

The German central bank spooked some bondholders last week when it set interest rates for just two out of the four weeks it is supposed to be on holiday, opening the door to a rise in interest rates in early August if it decides it has had enough of the mark falling against the dollar. Its chief economist, Otmar Issing, went as far as warning traders that "we aren't on vacation" as far as the currency market is concerned.

Nevertheless, with the pan-German economy growing just 0.4 per cent in the first quarter, some fund managers reckon the Bundesbank will be loath to risk pushing the economy back into recession by tightening monetary conditions, making bunds the better investment in the coming months. "There'll be no specific changes in policy from the Bundesbank," said Rod Davidson of Murray Johnstone International. He's stocking up on 10- and 30-year bunds and sees German debt outperforming the US in coming months.

The spread with Treasuries "will probably begin to widen again. The growth prospects are completely different; Germany's at a different stage from the US economy," Davidson reckons. If the German central bank continues to stand pat on rates, bunds should outperform Treasuries, investors said.

"We don't think rates will rise for the rest of the year," said Siermann at Robeco Group. "We see some growth coming through with the weakening of the mark but growth won't be too fast in bond market terms."

Start your day with The Independent, sign up for daily news emails
ebooks
ebooksA special investigation by Andy McSmith
  • Get to the point
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Neil Pavier: Commercial Analyst

£50,000 - £55,000: Neil Pavier: Are you a professionally qualified commercial ...

Loren Hughes: Financial Accountant

£45,000 - £55,000: Loren Hughes: Are you looking for a new opportunity that wi...

Sheridan Maine: Finance Analyst

Circa £45,000-£50,000 + benefits: Sheridan Maine: Are you a newly qualified ac...

Sheridan Maine: Financial Accountant

£150 - £190 Daily Rate: Sheridan Maine: One of London's leading water supplier...

Day In a Page

No postcode? No vote

Floating voters

How living on a houseboat meant I didn't officially 'exist'
Louis Theroux's affable Englishman routine begins to wear thin

By Reason of Insanity

Louis Theroux's affable Englishman routine begins to wear thin
Power dressing is back – but no shoulderpads!

Power dressing is back

But banish all thoughts of Eighties shoulderpads
Spanish stone-age cave paintings 'under threat' after being re-opened to the public

Spanish stone-age cave paintings in Altamira 'under threat'

Caves were re-opened to the public
'I was the bookies’ favourite to be first to leave the Cabinet'

Vince Cable interview

'I was the bookies’ favourite to be first to leave the Cabinet'
Election 2015: How many of the Government's coalition agreement promises have been kept?

Promises, promises

But how many coalition agreement pledges have been kept?
The Gaza fisherman who built his own reef - and was shot dead there by an Israeli gunboat

The death of a Gaza fisherman

He built his own reef, and was fatally shot there by an Israeli gunboat
Saudi Arabia's airstrikes in Yemen are fuelling the Gulf's fire

Saudi airstrikes are fuelling the Gulf's fire

Arab intervention in Yemen risks entrenching Sunni-Shia divide and handing a victory to Isis, says Patrick Cockburn
Zayn Malik's departure from One Direction shows the perils of fame in the age of social media

The only direction Zayn could go

We wince at the anguish of One Direction's fans, but Malik's departure shows the perils of fame in the age of social media
Young Magician of the Year 2015: Meet the schoolgirl from Newcastle who has her heart set on being the competition's first female winner

Spells like teen spirit

A 16-year-old from Newcastle has set her heart on being the first female to win Young Magician of the Year. Jonathan Owen meets her
Jonathan Anderson: If fashion is a cycle, this young man knows just how to ride it

If fashion is a cycle, this young man knows just how to ride it

British designer Jonathan Anderson is putting his stamp on venerable house Loewe
Number plates scheme could provide a licence to offend in the land of the free

Licence to offend in the land of the free

Cash-strapped states have hit on a way of making money out of drivers that may be in collision with the First Amendment, says Rupert Cornwell
From farm to fork: Meet the Cornish fishermen, vegetable-growers and butchers causing a stir in London's top restaurants

From farm to fork in Cornwall

One man is bringing together Cornwall's most accomplished growers, fishermen and butchers with London's best chefs to put the finest, freshest produce on the plates of some of the country’s best restaurants
Robert Parker interview: The world's top wine critic on tasting 10,000 bottles a year, absurd drinking notes and New World wannabes

Robert Parker interview

The world's top wine critic on tasting 10,000 bottles a year, absurd drinking notes and New World wannabes
Don't believe the stereotype - or should you?

Don't believe the stereotype - or should you?

We exaggerate regional traits and turn them into jokes - and those on the receiving end are in on it too, says DJ Taylor